How Prices Actually Get Set
"Every man lives by exchanging, or becomes in some measure a merchant." — Adam Smith, The Wealth of Nations (1776)
Two Ways to Buy a Tomato
Consider two places where you might buy a tomato in India.
Place one: a sabzi mandi. You walk through the rows. A vendor has tomatoes piled on a mat. You pick one up, squeeze it, examine its color. "Kitne ka hai?" you ask. He says forty rupees a kilo. You make a face. He says, for you, thirty-five. You say twenty-five. He says impossible. You start to walk away. He calls you back. Thirty. You say twenty-eight. He sighs. Done.
The price was discovered through negotiation. Both of you had information — he knew what he paid, what others were selling for, what he needed to earn. You knew what you paid last week, what the vendor next door was charging, how badly you needed tomatoes. The final price emerged from the collision of two sets of knowledge, mediated by the ancient art of haggling.
Place two: a supermarket. You walk in. The tomatoes sit in a tray with a sticker: Rs. 42/kg. You either take them or leave them. There is no negotiation. The price was set by someone in an office — a buyer, a pricing manager, an algorithm — using data about supply costs, competitor prices, and demand patterns. You have no say.
Same tomato. Two entirely different price-setting mechanisms. Two different answers to the question: who decides what this tomato is worth?
This chapter is about that question. Because prices are not just numbers. They are signals, weapons, compromises, and stories about power.
Look Around You
Think about the prices you encounter every day. Your rent — who decided that? The auto-rickshaw fare — is it negotiated or metered? The price of your mobile data plan — did you negotiate it? A doctor's consultation fee — is it based on what the doctor's time is worth, or what patients are willing to pay, or what the market will bear?
Notice how different the price-setting mechanisms are. For some things, you negotiate. For others, the price is given to you. For some, the government decides. There is no single "law" of prices.
The Supply-and-Demand Story
Every economics student learns the story of supply and demand. It goes like this:
When the price of something rises, suppliers want to sell more of it (they earn more per unit) and buyers want to buy less of it (it costs them more). When the price falls, the reverse happens. The price where the quantity supplied equals the quantity demanded is the "equilibrium price." The market naturally tends toward this price.
This is not wrong. It is a useful framework. If the monsoon fails and the wheat crop is poor, wheat prices rise. If a new factory opens making shoes, shoe prices fall. Supply and demand capture something real about how prices move.
SUPPLY AND DEMAND — THE TEXTBOOK VERSION
==========================================
Price │
(₹) │ S (Supply)
│ /
│ /
│ /
│ / ← Equilibrium
│ X (where S meets D)
│ / \
│ / \
│ / \
│ / \
│/ D (Demand)
└──────────────────────
Quantity
When supply increases → price falls
When demand increases → price rises
When both shift → it depends
Simple. Elegant. And about half the story.
But supply and demand, as taught in textbooks, carries hidden assumptions:
- Many buyers and many sellers, none big enough to control the price
- Everyone has the same information
- The product is identical no matter who sells it
- Buyers and sellers can freely enter and exit the market
- No government interference
In the real world, almost none of these hold.
When the Seller Sets the Price
In many markets, the price is not "discovered" through the meeting of supply and demand. It is set by the seller.
When Hindustan Unilever decides what to charge for a packet of Surf Excel, they do not check what "equilibrium" the market has found. They calculate their costs, estimate what consumers will pay, check what Tide is charging, factor in their brand value, and set a price. Then they spend millions on advertising to make you willing to pay it.
When a hospital sets the price of an MRI scan, it does not do so through supply-and-demand discovery. It considers the cost of the machine, the salaries of technicians, the prices at competing hospitals, the desperation of patients (who cannot easily shop around when they are ill), and the insurance framework.
When a landlord sets your rent, she considers her own costs, the rents of comparable properties, and — crucially — how badly you need a place to live in that location.
This is called price-setting power, and who has it matters enormously.
In a competitive market with many sellers of identical goods, no single seller has price-setting power. If one tomato vendor charges too much, you walk to the next one. This is the closest we get to the textbook model, and it does work — for tomatoes.
But for branded products, for services like healthcare, for housing in desirable locations, for products protected by patents — the seller has significant price-setting power. And they use it.
Cost-Plus: The Simplest Method
The simplest way to set a price is to calculate your cost and add a margin.
A chai stall owner knows his costs: tea leaves, sugar, milk, gas, cups, rent for the spot. He adds them up, divides by the number of cups he expects to sell, and adds enough margin to make it worth his while. If his costs come to six rupees per cup, he might sell at ten. His margin is four rupees.
This is cost-plus pricing, and it is how most small businesses operate. It is intuitive, straightforward, and fair in a simple sense: you charge enough to cover your costs plus a reasonable profit.
But cost-plus pricing has problems. It ignores what the customer is willing to pay. If you are the only chai stall at a railway station where passengers are desperately thirsty, you could charge twenty rupees and people would pay. Cost-plus pricing leaves money on the table. If you are one of twenty chai stalls on a street, you might need to cut your margin to survive.
And "cost" is not always obvious. When a pharmaceutical company develops a drug, should the price include only the manufacturing cost (a few rupees per pill) or also the research cost (billions of rupees over a decade)? The answer to this question determines whether drugs are affordable.
Market Pricing: What Will They Pay?
The opposite of cost-plus is market pricing — setting the price at whatever the market will bear.
This is what luxury brands do. A Louis Vuitton handbag does not cost three hundred times more to make than a decent bag from the local market. But Louis Vuitton charges three hundred times more because people will pay it. The price reflects not the cost of production but the value of the brand, the signal of status, the desire manufactured through decades of marketing.
Airlines are masters of market pricing. The same seat on the same flight can cost five thousand rupees or fifty thousand, depending on when you book, which class you choose, whether it is a holiday weekend, and what the airline's algorithm thinks you are willing to pay. This is called price discrimination — charging different prices to different customers for essentially the same product.
If it sounds unfair, consider this: the business traveler paying fifty thousand for a last-minute ticket is subsidizing the student who paid five thousand by booking two months early. Without price discrimination, the airline might have to charge everyone fifteen thousand — too much for the student, too little for the business traveler. Different prices enable the plane to fly full.
"In the long run, every price is a cost-plus price. In the short run, every price is a demand-determined price." — Adapted from Joan Robinson
What Actually Happened
In 301 CE, the Roman Emperor Diocletian issued the Edict on Maximum Prices — one of the most ambitious attempts at price control in history. The edict set maximum prices for over a thousand goods and services: wheat, wine, meat, shoes, textiles, transportation, even haircuts.
The penalty for charging above the maximum was death.
Why did Diocletian do this? The Roman Empire was experiencing devastating inflation. The currency had been debased (the silver content of coins was reduced to almost nothing). Soldiers could not afford food. Citizens were hoarding goods.
The result? Merchants stopped selling. If the maximum price was below their cost, they simply withdrew goods from the market. Black markets flourished. Goods became even scarcer. Within a few years, the edict was widely ignored and eventually abandoned.
The lesson: you can set a price by decree, but you cannot force people to sell at a loss. Price controls that ignore the underlying economics of supply create shortages. Diocletian's edict is history's most cited example — but far from the last.
Administered Prices: When the Government Steps In
In every country, some prices are not left to markets. They are set or influenced by the government.
In India, the most important example is the Minimum Support Price (MSP) for agricultural crops. Every year, the government announces the MSP for major crops — wheat, rice, cotton, sugarcane, and others. The MSP is a floor price: if market prices fall below the MSP, the government promises to buy at the MSP.
Why? Because agricultural prices are volatile. A good harvest can cause prices to crash (more supply, same demand). When prices crash, farmers cannot cover their costs. They go into debt. They lose land. Some take their own lives.
The MSP is meant to protect farmers from the worst of this volatility. It does not always work — government procurement is uneven, and many farmers in many states cannot actually sell at MSP because no government buyer shows up. But the principle is important: some markets are too important and too volatile to be left entirely to supply and demand.
Other administered prices in India include:
- Petrol and diesel prices — set by oil marketing companies under government influence
- Railway fares — set by the Railways, a government enterprise
- Electricity tariffs — set by state regulators
- Interest rates — influenced by the Reserve Bank of India through its policy rate
- Drug prices — essential medicines have price caps set by the NPPA (National Pharmaceutical Pricing Authority)
Each of these involves a political choice. Keep prices low, and consumers benefit but producers struggle. Keep prices high, and producers benefit but consumers suffer. Every administered price is a compromise between these tensions.
WAYS PRICES ARE SET — A SPECTRUM
==================================
← Government decides Market decides →
│ │
│ ADMINISTERED REGULATED NEGOTIATED FREE │
│ PRICES PRICES PRICES MARKET│
│ │
│ - Railway fare - Electricity - Mandi - Stock│
│ - MSP - Drug prices - Real market│
│ - Ration shop - Telecom estate - Gold │
│ prices rates - Salary - Onions│
│ - Subsidized - Insurance negotiation (volatile)│
│ LPG premiums - Auto fare │
│ (metered) │
│ │
│ Pure government Pure supply │
│ control and demand │
│ │
└────────────────────────────────────────────────────┘
Most prices fall somewhere in the middle.
Pure free markets and pure government control are both rare.
The Onion Price Problem
If you want to understand how prices actually work in India — and how powerful they are — study the onion.
The onion is India's most politically sensitive commodity. When onion prices spike, governments have fallen. This is not an exaggeration. In 1998, high onion prices contributed to the BJP's defeat in the Delhi state elections. Politicians know: do not let the onion price rise.
Why is the onion so volatile? Several reasons:
Perishability. Onions cannot be stored indefinitely. Once harvested, there is a window in which they must be sold. If too many farmers harvest at once, supply floods the market and prices crash. If the crop is poor, supply is tight and prices spike.
Concentration. Most of India's onions come from a few districts in Maharashtra (Nashik, Ahmednagar) and some parts of Karnataka and Madhya Pradesh. A localized drought or pest outbreak can affect national supply.
Thin markets. The onion market is "thin" — even small changes in supply cause large changes in price. A ten percent drop in supply can cause a fifty percent increase in price, because buyers compete fiercely for what is available.
Speculation. Traders sometimes hoard onions, betting that prices will rise. This can create artificial scarcity.
When onion prices spike, the government responds with a predictable sequence: banning exports, releasing buffer stocks, raiding traders for hoarding, and sometimes importing onions from Egypt or Turkey. These measures bring temporary relief but do not fix the underlying problem: India's onion supply chain lacks adequate storage, transport, and price-stabilization infrastructure.
The onion illustrates a broader truth: for necessities — food, fuel, housing, healthcare — price spikes cause real suffering. When your rent doubles, you cannot simply choose not to have shelter. When onion prices triple, the poor do not stop needing onions — they just eat less. This is why governments intervene in the prices of necessities, even though intervention creates its own problems.
Price Controls: The Promise and the Trap
Let us talk honestly about price controls — government-imposed limits on what sellers can charge.
The appeal is obvious. When prices are too high, people suffer. Capping the price seems like a direct solution. But the history of price controls is a cautionary tale.
Rent control. Many Indian cities have rent control laws, some dating from the colonial era. The idea was to protect tenants from exploitative landlords. The result, over decades, has been perverse. Landlords cannot raise rents to cover maintenance costs, so buildings deteriorate. New construction for rental is discouraged because returns are too low. The supply of rental housing shrinks. Those who have a rent-controlled apartment benefit enormously — some pay rents that have barely changed since the 1960s. But those who need new rental housing face a market starved of supply.
Mumbai's rent control, governed by the Maharashtra Rent Control Act of 1999 (replacing the earlier 1947 act), has contributed to a paradox: some of the world's most expensive real estate, and some of the most decayed buildings, sit side by side. The controlled rents made landlords unwilling to invest, and the housing shortage made market rents astronomical.
The lesson is not that price controls are always wrong. The lesson is that they have unintended consequences. Control the price without addressing the underlying supply problem, and you create distortions. Sometimes the distortions are worse than the original problem.
The most successful price interventions are those that pair price support with supply expansion. India's Public Distribution System (PDS), for all its flaws, does this: it provides subsidized food to the poor while also maintaining procurement systems that support farmers. The price is controlled, but the supply is managed too.
The Price of Everything and the Value of Nothing
Oscar Wilde's quip — that a cynic is "a man who knows the price of everything and the value of nothing" — contains a deep economic insight.
A price is not the same as a value. A price is what happens when a value meets a market.
The price of a painting by Amrita Sher-Gil might be twenty crore rupees at a Sotheby's auction. But what is its value? The beauty it brings to the viewer? The history it preserves? The inspiration it offers to young artists? These things have no price. They have value.
The price of a liter of clean water in a village without piped supply might be zero — nobody is selling it. But its value — the hours women spend walking to fetch it, the health consequences of drinking contaminated alternatives, the opportunities lost while fetching water — is enormous.
When we rely solely on prices to guide our decisions, we systematically undervalue things that are not bought and sold — clean air, family time, community bonds, ecological balance — and overvalue things that are — luxury goods, financial instruments, status symbols.
"The market is a useful servant but a dangerous master." — Attributed to various thinkers
SUPPLY AND DEMAND — WITH REAL-WORLD COMPLICATIONS
===================================================
Textbook says: │ Real world says:
───────────────────────┼──────────────────────────────────
Many buyers, many │ Often few sellers (oligopoly)
sellers │ or one dominant player
───────────────────────┼──────────────────────────────────
Perfect information │ Seller usually knows more
│ than buyer (info asymmetry)
───────────────────────┼──────────────────────────────────
Identical products │ Branding makes "identical"
│ products seem different
───────────────────────┼──────────────────────────────────
Free entry and exit │ Barriers: capital, licenses,
│ regulations, networks
───────────────────────┼──────────────────────────────────
No government │ Taxes, subsidies, MSP, price
interference │ controls everywhere
───────────────────────┼──────────────────────────────────
Rational buyers │ Advertising, impulse, status,
│ habit shape choices
───────────────────────┼──────────────────────────────────
Price adjusts │ Prices are "sticky" — wages
instantly │ take years to adjust, rents
│ lag, menus cost money to
│ change
───────────────────────┼──────────────────────────────────
Supply and demand is a MAP. The map is useful.
But the territory is far more complex than the map.
Who Has the Power?
In any price negotiation, the crucial question is: who has the power?
When you negotiate with the sabzi vendor, you have roughly equal power. She has tomatoes you want. You have money she wants. Either of you can walk away. There are other vendors and other customers. The negotiation is roughly fair.
But when a small farmer sells to a large food processing company, the power is unequal. The farmer has one harvest. It is perishable. He has debt to repay. He cannot wait. The company buys from thousands of farmers. It can wait. It has storage. It has alternatives. The "negotiation" is hardly that — the company sets the price, and the farmer takes it or leaves it.
When you negotiate your salary with a large employer, the power is often unequal. You need the job. The employer has many applicants. Unless you have a rare skill, the employer has price-setting power and you are the price-taker.
When a pharmaceutical company holds a patent on a life-saving drug, the patient has no bargaining power. The "demand" is not a preference — it is a necessity. The company can charge whatever it wants, constrained only by regulation and public outrage.
Price, in these cases, is not a neutral outcome of supply and demand. It is a reflection of power. And understanding who has power — and why — is more important than drawing supply-and-demand curves.
"The ideas of the ruling class are in every epoch the ruling ideas." — Karl Marx
Think About It
When you haggle with a vegetable vendor, what information do you use to decide what is a fair price? Where does that information come from?
Should the government set the price of essential medicines, even if it means pharmaceutical companies earn less and invest less in research? How would you balance access and innovation?
A landlord charges whatever the market will bear. A kirana store owner charges what his customers can afford. What is the difference, and why?
"Prices are just numbers." Do you agree? Or are prices moral statements about what society values?
The Bigger Picture
Prices are not natural laws. They are not discovered by some neutral market mechanism that produces "correct" answers. Prices are made — through negotiation, through power, through convention, through government action, through corporate strategy.
The supply-and-demand framework is useful. It helps us understand why prices move when conditions change. But it is a starting point, not an ending point.
In the real world, prices reflect power as much as they reflect scarcity. They reflect information — and information is rarely shared equally. They reflect institutions — the rules, regulations, and customs that structure markets. They reflect history — the accumulated weight of past decisions, policies, and structures.
The next chapter takes us deeper into one of the most important truths about real markets: information is never equal. When you buy a used car, the seller knows more than you. When you buy insurance, you know more than the insurer. This asymmetry — who knows what — shapes prices, markets, and outcomes in ways that the simple supply-and-demand story cannot capture.
When someone knows more than you, you are at a disadvantage. And that disadvantage is everywhere.
"The real problem is not to determine prices, but to determine the institutions within which prices are established." — Karl Polanyi